Greece is bigger than Lehman, markets do not understand the real default risk

Posted on 10 September 2011 with 3 comments from readers

European and US financial stocks were hit particularly hard over the past week as the Greek sovereign debt crisis worsened again and the country moved closer to a final default.

The splits among top European Central Bank policymakers was highlighted by the resignation of key officials, and it was reported that the German civil servants are drawing up contingency plans for a Greek debt default.

Lehman part two?

Across the Atlantic on Wall Street traders correctly observed that this appeared to be a European version of the Lehman Brothers insolvency that rocked the global financial system in late 2008. However, this analysis fails to comprehend the true scale of the impact of Greece going down.

For one thing the ECB resignations underline the absence of an institution comparable to the Federal Reserve in Europe. It will indeed be up to the individual nations to coordinate their response and this is a major weakness in a crisis.

For the moment Greece goes down the spotlight will shift to the next weakest nations, Ireland and Portugal and then the bigger fish Spain and Greece. Their interest rates will immediately lurch higher and threaten a similar slide into disaster that we see today in Greece with default risk topping 90 per cent on Friday.

The euro will crash in value as started to happen this week. Now what will that mean for the profits of US multinationals repatriating profits from the eurozone where they have a huge presence? This is not something yet priced into Wall Street, quite apart from the obvious dampening effect of a massive banking crisis on demand in the eurozone.

So we do not have a clue how Europe will muddle through a crisis of this scale, except to note that the resources are not yet in place and their is nobody endowed with the power to use them. The contagion impact will be felt long before anybody can even think clearly of how to put this into place.

Inter-bank lending freeze

The whole global financial system is connected by inter-bank dealings and these will also be subjected to massive disruption. In the eurozone we already have banks placing their reserves with the ECB and not each other.

As we saw in late 2008 a credit squeeze delivers a hammer blow to global trade as banks provide the letters of credit that enable cargoes to move around the world. That impacts the business of trading companies everywhere.

You also have to consider that the great Federal Reserve itself is low on ammunition to meet this crisis after a three year fight with the worst economic slump since the 1930s. President Obama’s plan for jobs got a poor response this week because it appeared inadequate and muddled.

In the meantime, Wall Street is still underestimating the crisis coming from Europe.